Question 1

Business evaluation based on balance sheet methods offers one key advantage: it considers the future earning potential of the business.

Accepted Answer

Business evaluation based on balance sheet methods only considers the current and past financial position of the business and does not take into account its future earning potential.

Question 2

The practice of taking money from sales without reporting it as income is called sliding.

Accepted Answer

The practice of taking money from sales without reporting it as income is called skimming, not sliding. Skimming is a form of tax evasion or fraud.

Question 3

Potential buyers should examine income statements, balance sheets, and income tax returns for the past three to five years.

Accepted Answer

Examining financial statements and tax returns is an important part of due diligence when considering purchasing a business. It provides insight into the financial health and profitability of the business.

Question 4

The balance sheet technique is one of the most commonly used methods of evaluating an existing business, although it oversimplifies the valuation process because it values a company only on the basis of its net worth.

Accepted Answer

The statement is true. The balance sheet technique considers only the net worth of the company, which may not fully reflect its true value.

Question 5

The most meaningful method of determining the value of an existing business's inventory is its book value.

Accepted Answer

The book value of inventory is simply the cost of the inventory items that have not yet been sold. However, the true value of inventory may be higher or lower than its book value due to factors such as market demand, obsolescence, and fluctuations in the cost of raw materials. Other methods of determining inventory value, such as market value or replacement cost, may provide a more accurate representation of the inventory's worth.

Question 6

Because so many business owners take money from their companies' sales without reporting it as income, a business buyer should expect to pay for undocumented, "phantom" profits when buying an existing business.

Accepted Answer

The answer of Because so many business owners take money...

Question 7

If the corporation, rather than the business seller, signs a restrictive covenant, the seller may not be bound by its terms.

Accepted Answer

This is because a restrictive covenant is a contractual agreement between parties, and the seller is not a party to the agreement if they did not sign it themselves. Therefore, they cannot be bound by its terms unless they agreed to it separately.

Question 8

A nondisclosure document is an agreement between a business buyer and a seller that requires the buyer to maintain strict confidentiality of all records, documents, and information he receives during the parties' negotiations.

Accepted Answer

This is an accurate description of a nondisclosure document.

Question 9

A business buyer can be held liable in product liability lawsuits for unsafe products that cause damage or injuries to customers even though they were made prior to the business purchase.

Accepted Answer

This is because product liability is based on the concept of strict liability, meaning that the seller and anyone in the distribution chain can be held responsible for injuries caused by a defective product, regardless of whether they were aware of the defect or not. As such, even if the buyer had no involvement in the design or manufacture of the product, they can still be held liable if they continue to sell it after becoming aware of its defects.

Question 10

Some buyers may assume that if profits are adequate, there will be sufficient cash to pay all of the bills and fund an attractive salary for themselves, but that is not necessarily the case.

Accepted Answer

Adequate profits do not always equate to sufficient cash flow, as cash flow is impacted by various factors such as accounts receivable, inventory levels, and capital expenditures. Therefore, assuming that there will be enough cash to pay bills and salaries solely based on adequate profits is not always accurate.

Question 11

A restrictive covenant prohibits the seller of an existing business from opening a competitive business within a specific time period and geographic area of the existing one.

Accepted Answer

A restrictive covenant is a type of agreement that limits an individual's ability to compete with another business after leaving their employment or selling their business. It typically includes limitations on time, geographic area, and type of business that can be started.

Question 12

Goodwill is an intangible asset that the business buyer cannot depreciate or amortize for tax purposes.

Accepted Answer

Goodwill can be depreciated or amortized for tax purposes, however, it is subject to certain rules and limitations set out by the tax authorities.

Question 13

Ralph buys a software business from Waldo in Columbus, Ohio. As part of the deal, Waldo signs a covenant not to compete by opening another software business anywhere in Ohio for the rest of his life. Such a covenant would be enforceable.

Accepted Answer

Covenants not to compete must be reasonable in both time and geographic scope to be enforceable. A lifetime ban covering an entire state is generally considered too broad and unreasonable.

Question 14

When an entrepreneur purchases an existing business, he or she essentially is purchasing its future profit potential.

Accepted Answer

When an entrepreneur purchases an existing business, they are acquiring the established customer base, brand recognition, and assets of the business, which can lead to future profits.

Question 15

Most small businesses have market values that exceed their book value.

Accepted Answer

Market value represents the perceived value of a business by investors, while book value represents the value of assets listed on a company's balance sheet. Most small businesses have intangible assets such as brand recognition, customer loyalty, and intellectual property that are not reflected in their book value, leading to a higher market value.

Question 16

Goodwill is the difference between an established successful business and one that has yet to prove itself.

Accepted Answer

Goodwill refers to the intangible value that an established business has built over time, including its reputation, customer relationships, and brand recognition. This gives the business a competitive advantage over new or unproven businesses that have yet to build their own goodwill.

Question 17

A letter of intent is a nonbinding document stating that a business buyer and a seller have reached a sufficient "meeting of the minds" to justify the time and the expense of negotiating a final agreement.

Accepted Answer

A letter of intent outlines the key terms of a potential deal between a buyer and a seller, and while it is not legally binding, it demonstrates a serious intention to move forward with negotiations.

Question 18

Many business owners show low profits in their businesses intentionally to lower their tax obligations.

Accepted Answer

It is a common tax strategy for business owners to decrease their profits by using deductions, expenses, and credits to lower their taxable income and reduce their tax obligations.

Question 19

If the owner of an existing business refuses to disclose the company's financial records, an entrepreneur who is considering buying it should walk away from the deal.

Accepted Answer

Without access to financial records, it is difficult for an entrepreneur to make an informed decision about the health and profitability of the business. It is important to have transparency and clear understanding of a company's financial state before any acquisition.

Question 20

Skimming is the act of taking money from sales without reporting it as income and it is an illegal and unethical practice.

Accepted Answer

Skimming is a form of fraud where an individual takes money from sales or other financial transactions and does not report it as income. Skimming is illegal and unethical, and can result in fines, legal action, and damage to a business's reputation.

Quiz 7: Buying an Existing Business